Why HDFC Small Cap deserves a Bronze

The fund shows promise but our analyst needs to see a longer track record to build conviction.

Date of Analysis: May 2017

Category: Small/Mid Cap

Analyst Rating: Bronze

Star Rating: 2 stars

Minimum Investment: Rs 5,000

Investment Style: Small Blend

Investment Process: The manager invests in tangible businesses and continues to hold them over the long term

Type of Portfolio: Well diversified portfolio with a focus on quality stocks; the top 10 corner 32.62% of the portfolio (April 2017)

Market Cap Bent: 41% of the portfolio is in small and micro stocks and less than 6% in large caps (April 2017)

While multiple strategy changes constrain our view, we remain positive on the fund from a forward looking perspective.

This fund was initially known as Morgan Stanley A.C.E Fund and invested across market caps. It was renamed HDFC Small and Mid-Cap fund following HDFC’s acquisition of Morgan Stanley’s schemes in 2014. In September 2016, the fund’s investment strategy underwent yet another change and was renamed HDFC Small Cap Fund, with a corresponding change in asset allocation.

The fund manager is good at what he does.

The fund seems to be stabilising at a portfolio level and we think that Chirag Setalvad's expertise and skill will hold the fund in good stead. Setalvad ranks amongst the best portfolio managers in the India Small/Mid-Cap Morningstar Category. He has been managing this fund since 2014 and has been associated with HDFC since 2007. We view his long tenure at the fund house as a positive.

The fund manager’s style gels well with the fund house.

Detailed and exhaustive research is central to his investment approach. Setalvad emphasises gaining an in-depth understanding of a business before investing. He seeks companies with proven track records, so he can gauge how they have held up during testing times.

There is a perceptible quality bias in the investment style, characterised by investments in companies with strong management team and robust business models. This inherent investment style is one that we have to come to associate with the fund company’s equity funds. Setalvad combines absolute and relative valuation parameters to select stocks that aren't too expensive relative to their growth prospects.

Be patient.

The manager is a patient investor with a long-term investment horizon, which gels well with the quality bias. Investors must also note that Setalvad’s tendency to make contrarian investments can result in a divergent showing versus the category over shorter time periods.

The fund deserves a positive rating.

We think it’s too short a time period to evaluate the fund’s performance since the strategy change. We would like to monitor the fund over a longer term before we are able to build further conviction. But our confidence in Setalvad’s capabilities and skills lead us to assign a Morningstar Analyst Rating of Bronze to this fund despite the strategy changes that it has witnessed.